Hey guys. I decided I wanted to do some analysis of renting vs purchasing at my local for small homes. I threw the below together to give me a way to compare and come up with a rational financial decision.

I wanted to take into account the savings of renting that you could use to invest in stocks/bonds/what have you and compare it to what we have after the 30 year mortgage was done.

I was surprised to see that just taking into account the costs and where I you will be at after 30 years from this single analysis, it seems like purchasing a home is the way to go.

Do you guys think I'm missing anything from my chart or did not take something into account or anything I could have done differently?

What do you guys think about buying vs renting?

The numbers would be a bit off for everything but the 8% fyi.

I didn't include renters insurance because the cost seemed negligible.

Not that it'll tip the scales or anything, but rent costs should be indexed to some form of inflation/rise. I believe that rent tends to move roughly in line with the general real estate trend. Of course that makes renting more expensive over time and thus less attractive.

There are a lot of variables and assumptions at play, some of which you need to look at carefully because they affect the outcome.

You're apparently doing an apples-to-apples comparison of a hypothetical house that you might rent and the same-sized house in the same neighborhood that you might buy. That makes for a fair comparison, but is it a realistic one? The reality for most people is that when you're renting, you often settle for a place that's smaller, not as nice, or in a different neighborhood than when you buy, because you don't have the same long-term commitment and you're more willing to make compromises when you're renting.

When I first moved to my city, we rented a 3-bedroom apartment that cost only $550/month and we stayed there for 5 years. Then we bought a three-bedroom house in a nicer neighborhood and my mortgage payments are $2,600/month.

You assume an appreciation rate for your house of 3.5%, and you make assumptions about investment income rates. Those are assumptions, of course, but small changes in those assumptions could have big impacts on the outcome.

Ultimately I think rent vs. buy decisions are best made on different criteria. One important one is how long you plan to stay in the area and stay in the house. If you really plan to buy a house and stay there for 30 years, then buying is probably a good idea. If you buy a house with a 30 year mortgage and you move after 5 years, you probably would have been better off renting, because with a 30-year mortgage you would have barely made a dent in your principal after 5 years.

Then there's the whole question of a 30-year mortgage, in which you would most likely be throwing away more than the entire cost of your home in interest, depending on how much you have for a downpayment. It's like paying for two houses but you're only left with one.

Rent vs. buy decisions are also not purely financial. There are emotional considerations around settling down, having a place to call your own, a sense of stability, etc., that play a role in the decision.

Labour cost (salary) over time should go in par with the economy in general (GDP growth). If not, labour takes a bigger or smaller share of the economy. Salary is the major part of the income for people who are net buyers (buy first, or buy bigger) of housing - in general people who are 18-45 years of age.

House prices on the other hand over time should go in par with income in general. If not, housing takes a bigger or smaller share of te income. Since housing spent the 20-30 years up to the financial crisis increasing compared to income, the chanses of such expansion seems bleak the upcoming years - or decades. Prices have tumbled, but problably just to a fair value, or (according to The Economist) a little bit under it. Looking at the next 20-30 years (or infact 500 years), you would be wise not to calculate house prices to increase at a faster pace than the economy in general. Looking at debt in US households, companys, states and at the federal level it is obvious that the economy will grow at a very low real rate if the debt is not somehow slashed by inflation. Since alot of the debt (state) is pension promises linked to salarys that (in time) will compensate for high inflation, my guess is you are looking at >10 years with lower growth than 1975-2005.

The twenty or so years running up to the financial crisis, USA had a decent GDP-growth, but labour cost did not tag along. Big parts of the US work force have had trouble keeping their salary in par with inflation. Commodity prices and capital gained ground (part of the economy). Results are capital owners have become richer and the conflicts of the world is more "commodity oriented".

Plain text: US growth will be relatively low the upcoming 10-20 years, as will income gains (from labour and capital) - and therefore gains in house prices. 1,5-2,5% a year seems reasoneble. In real terms my guess is US salarys and house prices will gain no ground the next 10-15 years.

Northern light wrote:Plain text: US growth will be relatively low the upcoming 10-20 years, as will income gains (from labour and capital) - and therefore gains in house prices. 1,5-2,5% a year seems reasoneble. In real terms my guess is US salarys and house prices will gain no ground the next 10-15 years.

There is a fairly sound basis for home prices to follow rebuilding costs. This is borne out by both historical data and common sense. (Why would anyone pay more for an appreciated older house rather than build a new one in the same location? You can point to historical value but that only applies in limited situations.)

Rebuilding costs basically follow inflation because houses use a diverse mix of labor and materials.

Together, the above two premises mean that housing prices can be expected to increase with inflation and no more. Inflation in the US will be around 2% for the next 30 years if you believe the bond markets.

So, I agree with Northern Light's numbers. If you back your assumed appreciation rate down to 1.5-2% things begin to look different.

DoingHomework wrote:Together, the above two premises mean that housing prices can be expected to increase with inflation and no more.

A defensible assumption for the United States as a whole, but nobody lives in the United States as a whole. Everyone lives in a particular community, and the law of supply and demand has an influence on housing prices there. If you buy in a community that gets improved over time and becomes very desirable, the value of your house can rise significantly.

I really think a person's rent-vs.-buy analysis isn't very useful if it's generic, because it simply compares hypothetical scenarios. Better to compare an actual rental unit (or house rental) that you're interested in vs. an actual home you'd like to buy, and also be honest with your own financial discipline (e.g., would you actually invest the difference if you were renting, or if you took out a 30-year vs. 15-year mortgage, or would you spend the extra money on other things?). It's a very personal, situation-specific, and place-specific analysis.

By the way, I rent my home and intend to do so in the forseeable future (4-8 years). I would like to build a new home, but even though the cost for the house at about $1.750 per square meter is OK, land is unreasonably expensive around Stockholm where I live. A small, 800-1.200 square meter lot somewhere quite remote from public transport and services, but still very close to neighbours is basically from $300.000 and up. The problem is not that big lots with ocean virew in great neighbourhoods is >$1.100.000, the problem is the small, mediocre ones in "OK" areas are $300.000. Unreasonable since there is tons of free space all around. Bubble warning.

Housing is not a cash machine, not a saving account and not a retirement plan. Housing is consumption that has a cost per time unit.

Northern light wrote:Housing is not a cash machine, not a saving account and not a retirement plan. Housing is consumption that has a cost per time unit.

I agree, although it was not always thus, nor does this necessarily hold true in all locations. My father bought a house in 1960 for $50,000 (in 1960 dollars) and sold it 30 years later for $850,000 (in ~1990 dollars). He then moved to a cheaper part of the country (he was retired by then), bought a house for about $100,00 and had a nice chunk of change to augment his pension during retirement.

Real estate can be a cash machine, but I certainly don't view my own personal home as anything but an abode. It's not really an investment; if it appreciates enough it may play into my retirement plans but I'm not counting on it. We plan to stay here a long time.

The way I did it was I increased the rent by rate of assumed inflation (over 100 years inflation and house prices tend to move together). I then took the total cost a amortized it over 30 year period and attempted to add that cost to the cost of rent.

The result was not pretty for the renter.

Can anyone think of a better way to do it? Taking the net increases and amortizing it equally felt like it gave me a unrealistic high number in the present so I took the present value of the net increases and amortized that on a equal basis instead.

I'm still trying to figure out where the estimated tax rate is coming from. I submitted a question to the provider of the information and am awaiting a response.

DoingHomework wrote:Together, the above two premises mean that housing prices can be expected to increase with inflation and no more.

A defensible assumption for the United States as a whole, but nobody lives in the United States as a whole. Everyone lives in a particular community, and the law of supply and demand has an influence on housing prices there. If you buy in a community that gets improved over time and becomes very desirable, the value of your house can rise significantly.

Yes, I agree. But that can also be virtually impossible to predict over 30 year time periods. Go back to 1982. Was it obvious that Detroit would be a virtual wasteland while places like Phoenix would be growing like mad? Perhaps, but I doubt anyone could have predicted growth rates well enough to make quantitative models. The people who got rich from real estate trends over the last few decades mostly did so by speculating. There are plenty of people who lost money too.

I own a house because I want a place to live. I own a second home as a place to vacation and a possible future retirement home. I don't view either as an investment.

DoingHomework wrote:Yes, I agree. But that can also be virtually impossible to predict over 30 year time periods.

Exactly, which is why I was suggesting that this kind of analysis is probably a waste of time because it's just a comparison of scenarios, none of whose likelihood can be predicted with any useful degree of accuracy, especially at the local level (which is where home purchases happen).

I think it's better to base the rent-vs.-buy decision on other considerations such as those you mentioned and the ones I mentioned further upthread.

DoingHomework wrote:Was it obvious that Detroit would be a virtual wasteland while places like Phoenix would be growing like mad?

If you were going to build a model from the data, wouldn't you throw both of those out as outliers?

Maybe. But the point is that you don't know what the outliers will be over the next 30 years. I was in Detroit 10 years ago. It was vibrant and in the middle of a revitalization. I would not have predicted it would fall so far so fast!